Ben Bernanke Better Warm Up the Printing Press

Last week, we spoke of an enterprising restauranteur in New York who put a USD $1,000 pizza on his menu. Upon further reflection, we think it is a shame that eateries aren’t required to run small-print disclaimers, like stock offerings. We’d like to see what it might say:

“This pizza might not taste a bit better than any other pizza…in fact, with its caviar, crème fraiche, and lobster, most people will probably think it sucks. Diners are also advised that several animals were harmed in the creation of this culinary offering…that fossil fuels were used in its preparation…and that buying it may do damage to the acquirer’s balance sheet as well as to his intestines and his planet. Still, if you and your buddies have just laid off a few billion dollars worth of subprime distillate upon a pension fund for widows and orphans, what better way to celebrate?”

There is so much easy money flowing through lower Manhattan, even a pizza-man must think, “It’ll be a piece of cake to skim some off.”

And he’s probably right. Corporate profits, generally, have been on a tear. And no profits have risen further or faster than the profits of the financial industry.

But why so much money in Wall Street and London’s City?

We have lots of answers, but no good ones. The theory of capitalism is that rising profits will attract additional investment, which will increase production, which will provide people with more of what they really want at lower prices – and, coincidentally, reduce profit margins down to normal levels.

But, what people really seemed to want in the early years of the 21st century was financial services. Why? Because there was so much ‘flation available. A smart hedge fund manager or investment banker could make himself and his clients a lot of money. And there was enough hocus-pocus, regulatory restrictions and capital requirements to keep new competitors out of the market – at least for a while.

Thus it was (and still is) that the world’s most capitalistic businesses seem to defy its most fundamental rules. It’s as if you had drunk a shot of whisky and immediately turned stone sober. Or if the Pope had interrupted mass to announce that he was an atheist. And there is no better emblem of this puzzling phenomenon than the latest profit report from gonzo banker, Goldman Sachs (about which there is more below).

But now, the story grows even more interesting…

You will recall how Ben Bernanke proposed to avoid following Japan into a long, dark slump. “We have a technology,” he said…reminding listeners that the feds could print up as many dollars as they wanted. Then, the chairman-to-be was a deflation fighter.

Now, he says it is inflation that should worry policy-makers. “The FOMC has continued to view the risk that inflation will not moderate as expected as the predominant policy concern,” he announced recently.

We doubt that consumer price inflation is really of that much concern. We also doubt that Ben Bernanke could do much about it even if it were. Who’s going to raise interest rates when the bottom end of a USD $10 trillion mortgage market looks ready to shimmy and shake?

Not Ben Bernanke.

No, the next move in fed rates is likely to be not up…but down.

‘Flation comes in various deceits and disguises. But the way it has been dressed up these last five years, it’s been welcomed everywhere like a long lost son. While the supply of money and credit – liquidity – rose to record levels at record rates, consumer prices remained relatively restrained. This ‘flation stayed mostly on the top rungs of the socio-economic ladder while practically everyone, everywhere else scrambled up to get a whiff of it.

The middle and lower classes did not suffer this ‘flation the way they suffered the consumer price inflation of the ’60s and ’70s. There was so much capital around, and markets had become so globalised, the Chinese could expand production in order to keep prices low. The one benefit the hoi polloi got turned out to be a curse in disguise…their houses rose in price. Nationwide, housing rose 102% from ’96 to ’07, according to The Economist. This pushed Americans’ total housing values to USD $22 trillion.

But, unfortunately, the middle classes didn’t merely enjoy having the extra cash in their pockets – they enjoyed spending it. Now, their houses are falling in price – so where’s the cash to come from? The latest news from Orange County, California, is that house prices have fallen for the first time since 1996 – down 0.4% year over year, says the local paper. The 10-year boom has busted.

Now what will consumers consume with?

And here we pose our readers a question: Imagine a neighbourhood where house prices have doubled – from USD $100,000 to USD $200,000. Now, all of a sudden, a neighbor sells his house. But he can only get USD $150,000 for it. What happened to all that extra ‘flation?

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.

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